Two weeks ago the price of bitcoin was about $350 higher in Asia than in North American, as I wrote in my previous article.
That’s a five percent spread, with bitcoin hovering close to $6500.
Even with trading and transfer fees, a five percent spread attracts investors familiar with the technique of arbitrage (the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset).
I was one of those arbitragers.
At present the spread is now under $150. It was easy money, and I will tell you how I did it.
First some background.
In the world of crypto, stablecoins are transferred between crypto exchanges as a method of eliminating price disparities.
For example, if the price of bitcoin is $6300 at an exchange in Japan, but $6400 at an exchange in the UK, an arbitrager will see the price difference and do the following:
Transfer stablecoins into the Japanese exchange.
Buy bitcoin at $6300
Transfer the bitcoin to the UK exchange.
Sell the bitcoin at $6400.
Convert the bitcoin to stablecoin.
See step #1.
Note that the arbitrager will continue to cycle this trading sequence until the price disparity shrinks to such a point that that transfer fees eat up all the profit.
Now, at this point, you may be asking “what is a stablecoin?”
In the world of crypto at stablecoin is digital coin or token that is backed by fiat currency. At present, all stablecoins are backed by the US dollars (supposedly, and we’ll get to that in a moment).
The ability to transfer US-backed stablecoins around the world in five minutes or less is crucial in enabling the crypto-ecosystem to eliminate price disparities between exchanges.
There is just one small problem. While each and every stablecoin dollar is supposedly backed by one US dollar, investors are not absolutely, positively convinced that is the case.
Sometimes doubt creeps in, and sometimes there is panic. And that’s what happened in the middle of October.
While other stablecoins are entering the marketplace, Tether has been the stablecoin of choice for most crypto exchanges for most of the year, with a market cap of just under $2 billion USD.
But two weeks ago, rumours came to a head that Tether coins were not backed 1-to-1 by US dollars, and there was a run on Tether. At one point it fell as low as 93 cents on some exchanges.
However, Bitfinex, one of the largest trading exchanges in the world (and based in Hong Kong) still honoured Tether at $1.00.
And this is what happened:
Because the price of Tether at Bitfinex was at least five percent higher than the price of Tether at exchanges in North America, then the price of EVERY crypto-coin at Bitfinex was five percent higher than at exchanges where Tether was “floating.”
You couldn’t arbitrage by buying cheap Tether outside of Bitfinex and then selling at parity, because everything was more expensive at Bitfinex.
There were two solutions to this problem.
One solution was to buy up cheap Tether outside of Bitfinex and sell for actual US dollars at the exchange (you can do that) and then wire the money to a bank account.
Then, wire the money to a to an exchange with cheap Tether, and repeat the process.
This is what has been happening over the last few weeks, as traders deposit their cheap Tether into Bitfinex, redeem them at 1:1 to the US dollar, and then wire the money to their accounts.
The only drawback to this method is that it is slow. It has been two weeks and finally the spread has to shrunk to under $150, or 2.3%.
However, I chose a second way to arbitrage.
First it was a near-certainty that as long as Bitfinex held the 1:1 pegging of Tether, that the price disparity of Bitcoin would be arbitraged away.
That is to say one of two things were almost guaranteed to happen: the price of bitcoin on Bitfinex would decrease to “street price,” or the “street price” of bitcoin would rise to the market price of bitcoin at Bitfinex.
Therefore, I shorted bitcoin on Bitfinex.
To cover the short, I bought bitcoin futures on Bitmex.
That way, I was not exposed to changes in the price of bitcoin. As long as the difference in price between Bitfinex and rest of world continued to shrink, I would make money.
My leverage on the Bitmex futures was 10:1. The futures contract is up 0.57% which means I have made 5.7% so far.
My leverage on the Bitfinex short was 2:1 and my trade is up 2.94%, for a total return of 5.88%.
Perhaps a return on investment of more than 5% in two weeks is not an eye-popper, but I will take it, especially since the chances of me losing money on the deal was close to zero.
All-in-all a good month for trading crypto, unlike equities, which are having a terrible October.